Commercial real estate investing is something I don't talk about very often.
Even though I've worked on the financing side of the commercial real estate business for over 8 years, I don't have much experience on the investing side.
Commercial investing has always intrigued me because it's kind of like residential investing on steroids. The wins are much bigger (as are the losses), the deals require a lot more capital (whether it's coming from you or from outside investors), the tenants tend to stay in place much longer (as do the vacancies) and in many cases, property management can require far less attention than most residential properties will.
To get started in commercial investing, you'll need both knowledge and confidence in what you're doing and since I'm not really qualified to impart either of these things in this realm, I wanted to share with you some insights from someone who is.
Matt Sarson of Emerging Property is a certified commercial real estate expert and as I think you'll see, there is a whole new world of opportunity in this niche if you ever decide to steer your business in this direction. Take it away Matt!
Commercial real estate investments have the potential to provide investors with hassle-free high NET yields and healthy capital growth potential. This is a draw for any investor. There are, however, some key questions to ask to ensure that you're working with a quality and secure investment.
1. Is There Sustained Demand?
Demand is one thing, but sustained demand quite another. When investing in commercial real estate, you are targeting a specific demographic for tenancy. This makes assessing demand straightforward. When it comes to student housing, for example, there are a number of critically under-supplied cities, where demand will remain high for many years. Despite current demand in other cities, relatively high saturation and a large number of new developments will see demand waiver at some stage in the years to come.
This is a crucial aspect of any development as high, sustained demand will ensure that your investment remains attractive in the long-term, maintaining yields, ensuring ease of exit and improving capital growth potential.
2. Is It A Good Location?
It goes without saying that location is a key component of any real estate investment. The same is true for commercial real estate, although the rules are slightly different.
A city that is attractive for a residential real estate investing may not necessarily be profitable for things like student housing, self-storage, car parks or other commercial assets. Thorough due diligence must be conducted to deem why a location is able to attract high occupancy and thus high profitability. In addition to selecting a suitable city for investment, it is also important to ensure that the positioning of a development within that city is attractive, with the different factors impact various sectors.
3. Do The Guarantees Make Sense?
The first thing to consider with regard to the security of a property's guaranteed income period is to ensure they make sense. Make local comparisons with other properties regarding rental demands and assess the demand for such a property in a specific location.
4. Can I Trust The Developer?
Regardless of how good a location might be, if the developer is of poor quality or inexperienced in their trade, the property may have limited profit potential. The available yields in commercial real estate have attracted a lot of new and inexperienced developers, who must be avoided.
It is also worth looking at the performance of past developments (ideally in the same sector) in order to ascertain whether they have a good track record.
5. What If I Need Access To My Money?
A flexible exit strategy is an absolutely crucial element in any commercial real estate investment. Although the sustained attractiveness of your investment property is a major element of this, the specific investment conditions you agree to also have a huge influence.
Long guaranteed income periods (with attractive yields) represent the best conditions to ensure a flexible exit strategy. They provide investors with the opportunity to leave at any stage during the investment cycle while presenting buyers with attractive conditions on a fully operational and proven development. The healthy capital growth of up to 40% is also highly achievable, with initial high yields suggesting a below market value investment level – often the case with new builds especially. Such flexibility is not available with shorter guaranteed income periods, due to less attractive investment conditions being available at resale.
Another common investment condition is guaranteed buy-backs. Although these can still provide flexibility, they have to be heavily scrutinized before investing. Any guaranteed buy-back should be based on a tried and tested business model and not mere projections.
6. Does It Fit With My Objectives?
Two key elements of security that some investors overlook is:
- How well an investment suits their own objectives
- What place it will take up within an existing portfolio.
What might be a great investment for one investor may not suit another. Also keep in mind that diversity is important, and commercial property offers a great opportunity to achieve this without investing a fortune.
7. What Are The Risks?
A key aspect of a successful investment is mitigating risk. In commercial property, this can be achieved by considering all of the above, while also ensuring that contracts are robust and asset-backed (it is common for developers to set up third-party shell companies through which they underwrite guarantees – this is highly insecure, as they commonly have zero assets).
It is always a good idea to consider the worst possible scenario. What impact will this have and what security is in place for you to protect you against it?
By asking the questions outlined above, you can go quite a ways in ascertaining whether an investment is secure, profitable and right for you. However, the most important thing is to ask a professional consultant any questions that come into your head, regardless of how silly it may seem to you. One of the most crucial aspects of security in any investment is your own understanding – and even if this takes 100 questions, so be it.
To learn how to properly conduct the due diligence process, check out The Due Diligence Handbook for Commercial Real Estate by Brian Hennessey (and get 25% off by using promo code TIPSTER at checkout).
As Head of Content for Emerging Property, Matt Sarson is a widely respected expert in the commercial property market. His analysis of student, retail and other areas can be found dispersed across a range of nice online and printed publications.